Viewing cable 04VILNIUS1526 Title: IMF'S RECOMMENDATIONS ON HOW TO PROLONG THE

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04VILNIUS1526

2004-12-17 13:37:00

2011-08-30 01:44:00

UNCLASSIFIED

Embassy Vilnius

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 02 VILNIUS 001526
SIPDIS
STATE FOR EUR/NB (MGERMANO) AND EB/IFD
E.O. 12958: N/A
TAGS: EINVECONLH
SUBJECT: IMF'S RECOMMENDATIONS ON HOW TO PROLONG THE
LITHUANIAN ECONOMIC MIRACLE
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SUMMARY
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Â¶1. An IMF delegation, concluding an Article IV
Consultation mission to Lithuania December 10, praised
Lithuania's impressive structural improvements and the
country's complete transition to a market economy. The IMF
delivered an overall positive assessment of the country's
economic prospects for 2005 and several short-term policy
prescriptions to ensure continued growth. The IMF
delegation warned that the economy risks overheating,
however, and also advised attention to remaining fiscal and
other structural reforms. Congratulating the GOL on the
economy's performance, the mission was optimistic that
Lithuania would speedily adopt the euro and attain the
living standards of more advanced European countries. The
IMF's policy prescriptions provide an agenda for the new
GOL's Ministry of Finance and guideposts for our advocacy
and reporting of their progress. End Summary.
Â¶2. An IMF delegation under the leadership of the Fund's
European Department Assistant Director Ashoka Mody
concluded an Article IV consultation on December 10. The
mission's overall analysis lauded Lithuania's structural
reforms. The delegation congratulated the GOL on the
economy's strong performance since the last IMF
consultation in June 2003, Lithuania's accession to the EU,
and the country's entry into the ERM-II currency mechanism.
The mission noted Lithuania's continued robust, non-
inflationary growth in 2004, declining unemployment, and
predicted GDP growth of 6.5 percent in 2005, and annual
growth of five to six percent in the medium term.
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IS LITHUANIA OVERHEATING?
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Â¶3. The IMF cautioned that Lithuania's fast growth rates
would stimulate aggregate demand to grow above potential,
leading either to destabilizing inflation or greater
borrowing, with higher current account deficits and
external debt. They noted that inflation, expected to be
just under 1.5 percent in 2004, will likely exceed 2.5
percent in 2005, and remarked several early signs that
point to a risk of overheating of the Lithuanian economy:
- High capacity utilization;
- Continued robust growth of credit, driven by low interest
rates;
- Declining unemployment;
- Acceleration in wage growth;
- Increases in property prices;
- Rapid growth in the current account deficit; and
- Output exceeding potential.
The mission stated that supply-side shocks are exerting
inflationary pressures, noting that recent increases in oil
prices had raised domestic prices because of the high
energy-intensity of Lithuania's production. It noted,
however, that domestic demand is equally inflationary,
pointing to the sharp increase in real estate prices, and
added that there is a continuing risk of price increases in
utilities and other non-traded goods.
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URGES TWO PERCENT FISCAL DEFICIT TARGET
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Â¶4. The IMF noted that Lithuania's current account deficit
has widened sharply. The mission recommended the GOL
closely monitor external debt obligations, take measures to
raise the private savings rate, and reduce the fiscal
deficit, since the latter contributes significantly to the
demand pressures underlying the current account deficit.
Â¶5. Commending the GOL for accepting the fiscal discipline
of the Maastricht criteria in order to achieve early
adoption of the euro, the mission encouraged the GOL to
adopt an even more ambitious fiscal deficit target for 2005
of two percent of GDP, rather than the current 2.5 percent
target. It suggested the GOL could reduce the fiscal
deficit by taking advantage of the high projected revenue
in 2004 and transferring domestic co-financing funds to
2005, since these will not be needed in 2004 due to the
delay in the utilization of EU funds. The mission observed
that a conservative fiscal policy would prevent
overheating, while allowing the GOL the flexibility to
increase the deficit in the future in order to stimulate
demand, should domestic confidence fall unexpectedly.
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URGENT: REFORMS TO ENSURE LONG-TERM GROWTH
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Â¶6. The IMF urged the GOL to implement fiscal and other
structural reforms to ensure a stable revenue base and
create incentives for private entrepreneurs to increase
employment, invest in upgrading the quality of the labor
force, and better enable their enterprises to compete
against lower-wage economies in international markets. The
mission recommended the following reforms:
- More effective collection of VAT revenues to remedy the
shortfall in 2004, and reforming the VAT tax administration
system;
- A significantly lower and unified single personal income
tax rate that would maintain the current exemption
threshold and would be appropriately phased in to limit
disruption to revenues, along with greater efforts at
achieving tax compliance;
- Institution of a more wide-ranging property tax, to both
increase revenues and provide incentives to municipalities
to invest in education, infrastructure, and public
services;
- Greater transparency and control in the design and
management of public expenditures, to include detailed
documentation of government expenditures and cash flows,
identification of buffers to deal with contingencies, and
institution of modern cash control methodology;
- a more financially viable social security system
featuring accelerating increases in the retirement age;
- Expansion of the social safety net, by devising a means-
tested targeting system for income support, but not by
raising the minimum wage, since the latter is already high
relative to other countries and a further increase would
only serve to discourage employment;
- Introduction of a Fiscal Responsibility Act in parliament
which would contain GOL commitments to targets, procedures,
and transparency of budget revenues, expenditures and debt,
and would provide a comprehensive and transparent framework
to ensure long-term fiscal reforms; and
- Additional microeconomic reforms to increase the
attractiveness of Lithuania's business environment, such as
decreasing complex and time-consuming regulations facing
small and medium enterprises, increasing private
initiatives in the health and education sectors, and
implementing World Bank recommendations on the knowledge
economy.
The mission concluded that a GOL focus on these short-term
policy prescriptions would ensure early adoption of the
euro and rapid improvement of living standards to match
those of more advanced European countries.
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COMMENT
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Â¶7. The IMF prescriptions are timely, coming just as a new
Government takes office. The IMF framed the challenge
well: Lithuanian elites must now decide how quickly
Lithuanian income levels will converge with those in
Western Europe. To catch up quickly, this Government and
Parliament will have to forget about the populist platforms
that helped elect many of them and adhere instead to the
IMF's recommendations.
MULL